Financial Development, Firm Growth, and Aggregate Productivity Divergence in Europe

Abstract

Since the information and communications technology revolution, productivity growth in Southern European countries has been substantially lower than in developed European countries. I document that Spanish firms have lower productivity growth, lower intangible capital growth, and lower leverage than German firms. The disparity is larger among smaller firms. I build a model featuring endogenous firm productivity growth through innovation investment and size-dependent financial frictions to rationalize these findings. The model finds that financial frictions account for 11% of the aggregate productivity growth difference in the data. The model mechanism and predictions are also supported by evidence in other European countries.